PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA CHAPTER 11 REPORTING AND INTERPRETING OWNERS’ EQUITY McGraw-Hill/Irwin Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.

UNDERSTANDING THE BUSINESS Simple to become an owner Easy to transfer ownership Provides limited liability Advantages of a corporation Because a corporation is a separate legal entity, it can... Own assets. Sue and be sued. Incur liabilities. Enter into contracts. 11-2

OWNERSHIP OF A CORPORATION  Voting (in person or by proxy).  Proportionate distributions of profits (dividends).  Proportionate distributions of assets in a liquidation Rights Stockholders’

Elected by shareholders Appointed by directors OWNERSHIP OF A CORPORATION 11-4

Issued shares are authorized shares of stock that have been sold. Unissued shares are authorized shares of stock that never have been sold. Authorized shares are the maximum number of shares of capital stock that can be sold to the public. AUTHORIZED, ISSUED, AND OUTSTANDING SHARES 11-5

Unissued Shares Treasury Shares Outstanding Shares Issued Shares Treasury shares are issued shares that have been reacquired by the corporation. Outstanding shares are issued shares that are owned by stockholders. AUTHORIZED, ISSUED, AND OUTSTANDING SHARES 11-6

EARNINGS PER SHARE (EPS) Kroger’s income for 2012 is $602,000,000 and the average number of shares outstanding is 597,000,000. Earnings per share is probably the single most widely watched financial ratio. $602,000, ,000,000 Shares EPS = = $1.01 per share *If there are preferred dividends, the amount is subtracted from net income. Net Income* Average Number of Shares Outstanding for the Period EPS = 11-7

EARNINGS PER SHARE (EPS) 11-8

COMMON STOCK TRANSACTIONS Retained earnings Contributed capital Common stock, par value Capital in excess of par value 11-9 Two primary sources of stockholders’ equity

COMMON STOCK TRANSACTIONS Dividend set by board of directors Basic voting stock Ranks after preferred stock 11-10

COMMON STOCK TRANSACTIONS Legal capital is the amount of capital, required by the state, that must remain invested in the business. Par Value Nominal value Legal capital 11-11

Par Value Market Value  COMMON STOCK TRANSACTIONS Some states do not require that a par value be stated in the charter. Some states do not require a par value to be stated in the charter

INITIAL SALE OF STOCK Initial public offering (IPO) Seasoned new issue The first time a corporation sells stock to the public. Subsequent sales of new stock to the public. Kroger issues new stock

The journal entry to record this transaction is: Kroger issued 100,000 shares of $1 par value common stock for $20 per share. INITIAL SALE OF STOCK 11-14

SALE OF STOCK IN SECONDARY MARKETS Transactions between two investors that do not affect the corporation’s accounting records. I’d like to sell some of my Kroger stock. I’d like to buy some of your Kroger stock

STOCK ISSUED FOR EMPLOYEE COMPENSATION Employee If Kroger does not have new stock to issue when the stock options are exercised, then... Stock options allow employees to purchase stock from the corporation at a predetermined, fixed price. Employee compensation package includes salary and stock options

REPURCHASE OF STOCK Kroger buys its own stock in the secondary market. (Treasury Stock) Stockholders Repurchased stock is called treasury stock. A corporation records treasury stock at cost. Treasury stock has no voting or dividend rights. Treasury stock is not an asset. It is a contra equity account

Kroger reacquired 100,000 shares of its common stock at $20 per share. REPURCHASE OF STOCK The journal entry to record this transaction is:

Kroger reissued 10,000 shares of the treasury stock at $30 per share. REISSUANCE OF TREASURY STOCK The journal entry to record this transaction is:

DIVIDENDS ON COMMON STOCK Declared by board of directors. Not legally required. Creates liability at declaration. Requires sufficient Retained Earnings and Cash. Declaration date Board of directors declares the dividend. Record a liability

Date of Record Stockholders holding shares on this date will receive the dividend. (No entry) DIVIDEND DATES Date of Payment Record the dividend payment to stockholders

DIVIDEND YIELD RATIO Dividend Yield Dividends Per Share Market Price Per Share = This ratio is often used to compare the dividend-paying performance of different investment alternatives. In 2012, Kroger paid a dividend of $0.36 per share and the market price of a share of Kroger stock was $22. Dividend Yield $0.36 per share $22 per share = = 1.6% 11-22

STOCK DIVIDENDS Distribution of additional shares of stock to owners. No change in total stockholders’ equity. All stockholders retain same percentage ownership. No change in par values. Stock dividend < 20-25% Record at current market value of stock. Small Stock dividend > 20-25% Record at par value of stock. Large 11-23

STOCK DIVIDENDS The stock dividend did not change total stockholders’ equity. It changed only the balances of two accounts within stockholders’ equity. Assume The Kroger Co. issued a large stock dividend. The company issued 400,000,000 shares of its $1 par value stock. The journal entry to record the stock dividend is: 11-24

Stock splits change the par value per share, but the total par value is unchanged. STOCK SPLITS Assume that a corporation had 3,000 shares of $2 par value common stock outstanding before a 2–for–1 stock split. Increase Decrease No Change 11-25

STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY 11-26

PREFERRED STOCK Preference over common stock Usually has no voting rights Usually has a fixed dividend rate 11-27

INTERNATIONAL PERSPECTIVE— WHAT’S IN A NAME? US GAAP and IFRS use different words to describe the same corporate equity accounts

 Current Dividend Preference: The current preferred dividends must be paid before paying any dividends to common stock stockholders.  Cumulative Dividend Preference: Any unpaid dividends from previous years (dividends in arrears) must be paid before common dividends are paid.  Current Dividend Preference: The current preferred dividends must be paid before paying any dividends to common stock stockholders.  Cumulative Dividend Preference: Any unpaid dividends from previous years (dividends in arrears) must be paid before common dividends are paid. DIVIDENDS ON PREFERRED STOCK If the preferred stock is noncumulative, any dividends not declared in previous years are lost permanently

Kites, Inc. has the following stock outstanding: Common stock: $1 par, 100,000 shares Preferred stock: 3%, $100 par, cumulative, 5,000 shares Preferred stock: 6%, $50 par, noncumulative, 3,000 shares Dividends were not paid last year. In the current year, the board of directors declared dividends of $50,000. How much will each class of stock receive? DIVIDENDS ON PREFERRED STOCK 11-30

DIVIDENDS ON PREFERRED STOCK 11-31

RESTRICTIONS ON THE PAYMENT OF DIVIDENDS Why would you want to do that? If I loan you $150,000, I will want you to restrict your retained earnings Retained earnings restrictions often limit borrowing and limit the amount of dividends that can be paid.

EFFECT ON STATEMENT OF CASH FLOWS 11-33

A sole proprietorship is owned by a one person. Two equity accounts CapitalDrawings CHAPTER SUPPLEMENT ─ ACCOUNTING FOR OWNERS’ EQUITY FOR SOLE PROPRIETORSHIPS AND PARTNERSHIPS 11-34

SOLE PROPRIETORSHIPS J. Doe started a retail store by investing $150,000 of his own money. The journal entry to record this business formation is: Each month, J. Doe withdraws $1,000 for personal living expenses. The January 30 journal entry to record the first withdrawal is: 11-35

SOLE PROPRIETORSHIPS During the first year, J. Doe’s income totaled $18,000, and his withdrawals totaled $12,000. The equity section of J. Doe’s balance sheet at the end of the first year is: During the first year, J. Doe’s income totaled $18,000, and his withdrawals totaled $12,000. The equity section of J. Doe’s balance sheet at the end of the first year is: 11-36

PARTNERSHIPS A partnership is owned by two or more individuals. Partnerships require clear agreements about authority, risks, and the sharing of profits and losses. A partnership is owned by two or more individuals. Partnerships require clear agreements about authority, risks, and the sharing of profits and losses. Separate capital and drawings accounts are maintained for each partner. Partnership income is divided among the partners according to the partnership agreement. Advantages Complete control by partners No income taxes on business itself Primary disadvantage Unlimited liability Ease of formation 11-37

Able and Baker formed a partnership. Able contributed $60,000 cash. Baker contributed $40,000 cash. The partners agreed to divide partnership income in the ratio of their contributions (60:40). The journal entry to record this business formation is: PARTNERSHIPS 11-38

The partners agreed that each month Able would withdraw $1,000 and Baker would withdraw $650. The January 30 journal entry to record the first withdrawal is: PARTNERSHIPS 11-39

PARTNERSHIPS During the first year, partnership income totaled $30,000. Withdrawals totaled $12,000 for Able and $7,800 for Baker. The equity section of the partnership balance sheet at the end of the first year is: 11-40

ACCOUNTING AND REPORTING FOR THREE TYPES OF BUSINESSES 11-41

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